resident Bush signed the Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005 (the "Act") into law on April 20, 2005.
This new law makes the most significant changes to the U.S. Bankruptcy
Code (11 U.S.C. § 101 et seq.) since the Bankruptcy Reform Act of
1978. The President's signing of the law came after nearly nine years of
heated debate, public hearings, negotiations, and amendments.

The Act is controversial in that it makes
fundamental changes in bankruptcy law. Many of the provisions have been
widely criticized by bankruptcy specialists, including academicians,
practitioners, and judges. Nonetheless, these modifications have now
become law, and it will be the responsibility of everyone who practices
in the area to understand the changes and to operate effectively under
them.

The Act makes more than 150 amendments to the Bankruptcy Code, in
addition to enacting new Chapter 15, which addresses cross-border
insolvencies. This article highlights several significant
modifications.

New legislation already has been proposed to clean up conflicting and
unclear Act provisions, although no new substantive changes are
expected. In addition, the Federal Rules of Bankruptcy Procedure and
each federal district's local rules likely will be amended to make them
consistent with the Act.

Effective Dates

Most provisions of the Act become effective on Oct. 17, 2005 (the
"effective date") and do not apply to cases filed before the effective
date.1 However, several provisions became
effective immediately on enactment and apply either to cases commenced
on or after the enactment date or retroactively to pending cases. The
amendments to provisions related to the homestead exemption apply to
cases commenced on or after April 20, 2005.2
The amendments to provisions related to recovering fraudulent transfers
apply only to cases commenced more than one year after April 20,
2005.3 The amendments to provisions relating
to recovering insider preferences apply to cases currently pending or
commenced after April 20, 2005.4 The
amendments to provisions related to the nondischargeability of debts
incurred in violation of securities fraud laws apply to cases filed on
or after July 30, 2002 (the effective date of the Sarbanes-Oxley
Act).5

Several other provisions also have specific effective dates.
Practitioners should review the Act carefully to verify which amendments
are already in effect.

Administrative Expense Priorities

The treatment of administrative expenses is one of the most
significant but least noted changes made by the Act. By definition,
administrative expenses are expenses that must be paid before a plan is
confirmed or before assets are distributed to any unsecured creditors,
including priority creditors. Under the Act, all administrative and
other priority expenses are now subordinate to domestic support
obligations.6

Randall D.
Crocker, Marquette 1979, is president of von Briesen &
Roper s.c., Milwaukee and chair of its Banking, Bankruptcy and Business
Restructuring Group.

Rebecca H.
Simoni, Minnesota 1999, is a principal associate in the
firm's Banking, Bankruptcy and Business Restructuring Group.

The Act expands some administrative expenses and limits others.
Administrative expenses include wages and benefits awarded as back pay
to a debtor's employees through a judicial proceeding or a proceeding
before the National Labor Relations Board that arise from the debtor's
violation of federal or state law, if the wages and benefits are
attributable to time worked after the bankruptcy case commences.7 This change makes claims arising out of violations
of the Wisconsin or federal Worker's Adjustment and Retraining
Notification Acts8 administrative expenses,
but only if the court determines that payment of those wages and
benefits will not substantially increase the probability of layoff or
termination of current employees or of nonpayment of domestic support
obligations during the bankruptcy case.9 It
is unclear if the last clause of this provision applies to nonpayment of
domestic support obligations by the debtor's employees, or by the
debtor. In light of the priority given to domestic support obligations
throughout the Act, courts are likely to construe this provision to
cover both.

In addition, actual and necessary costs and expenses incurred by a
trustee or federal agency in closing a health care business, including
the costs associated with disposing of patient records or transferring
patients as a result of a closure, can now be paid as an administrative
expense.10

But perhaps the most significant change is that the value of any
goods the debtor received within 20 days before the bankruptcy case
commenced are payable as administrative expenses, if the goods had been
sold to the debtor in the ordinary course of the debtor's
business.11 The Act is unclear as to how
the "value" is to be determined. Value is most often determined to be
the price set forth in the contract between the debtor and the nondebtor
party. However, the contract price is not determinative of value. It is
unresolved as to whether the relevant value is the value to the debtor
or to the nondebtor. This provision should encourage debtors and
potential providers of debtor-in-possession financing to work out a way
to continue paying current suppliers before the bankruptcy filing. This
amendment also raises significant questions. If a debtor loads up on
inventory pre-petition, will the resulting obligations be considered to
be incurred in the ordinary course of business?

The Act specifically excludes from administrative expenses transfers
to or obligations incurred for the benefit of an insider that are
intended to induce the insider to remain with the debtor's
business.12 With respect to individual
debtors, "insiders" generally include the debtor's relatives or
partners, and the corporation in which the debtor is a director,
officer, or person in control.13 With
respect to corporations, insiders are directors, officers, persons in
control, partnerships in which the debtor is a general partner, and
relatives of any of these parties.14 These
"stay bonuses" will only be approved if the court finds, based on the
evidence in the record, that:

1) the stay bonus is essential to retain the person because the
person has a bona fide job offer from another business for the same or
greater compensation;

2) services provided by the person are essential to the business's
survival; and

3) the transfer amount to be made or the obligation to be incurred is
not greater than 10 times the amount of the mean transfer of a similar
kind given to nonmanagement employees for any purpose. If no such
payments were made to nonmanagement employees, the transfer amount
cannot be greater than or equal to 25 percent of the amount of any
similar transfer or obligation made to the insider for any purpose
during the calendar year before the transfer was made. This means that
the court can find such bonuses to be administrative expenses if it
makes the required findings.

A severance payment will not be accorded administrative expense
priority unless the payment is part of a program generally applicable to
all full-time employees, and the amount is not greater than 10 times the
amount of the mean severance pay awarded to nonmanagement employees
during the calendar year in which the payment is made. These provisions
severely limit a troubled company's ability to provide financial
incentives to its management personnel to remain during the bankruptcy
proceeding.

Changes to Chapter 11

Congress has adopted many changes that are intended to streamline the
Chapter 11 bankruptcy process, expedite cases to their conclusion, and
grant additional authority to the Office of the United States
Trustee.

The court may dispense with the meeting of creditors in a Chapter 11
case in which a prepackaged plan has been approved pre-petition.15 A prepackaged plan is one for which the debtor
solicited acceptances before commencing the bankruptcy case.16

The membership of a creditors' committee may be changed at the
request of a party in interest. In addition, the court may order the
U.S. Trustee to change the committee's membership to ensure adequate
representation of creditors or equity security holders.17 Moreover, the court may increase the number of
members to include a small business concern if the committee represents
claims that are disproportionately large in relation to gross
revenues.18 The intent here is to allow
smaller entities to serve on the creditors' committee so that large bond
and other claimants cannot dominate the reorganization process.

The duties of the creditors' committee have been expanded and the
committee now has the responsibility to provide access to creditors
whose claims are of the kind represented by the committee but who are
not committee members.19 Additionally, the
committee has the responsibility to solicit and receive comments from
creditors and may be compelled, by court order, to provide reports and
disclosures.20

In Chapter 11 cases filed by individuals, the definition of "property
of the estate" has been expanded to include property acquired from
personal services income earned post-petition.21 This change requires that the debtor's
post-petition earnings in a Chapter 11 bankruptcy be used as part of the
plan assets.

Modifications have been made to expedite the plan confirmation
process. The debtor's 120-day exclusive period for filing a plan may not
be extended beyond a date that is 18 months after the date of the order
for relief.22 The debtor's 180-day
exclusive period for plan confirmation may not be extended beyond a date
that is 20 months after the date of the order for relief.23

Plan confirmation provisions have been modified to provide that tax
claims must be paid in regular cash installments within five years from
the date of the petition or in a manner not less favorable than the most
favored unsecured nonpriority claim.24 In
cases filed by individuals, all domestic support obligations payable
pursuant to judicial or administrative order, or by statute, which first
become payable after the date the petition is filed, must be paid in
full.25 Cram-down provisions for individual
debtors filing under Chapter 11 (pursuant to which a plan can be
confirmed over creditors' objections in certain circumstances) have been
modified to be consistent with similar provisions in Chapter 13.26

The debtor's disclosure statement must include an analysis of
potential tax consequences under any Chapter 11 plan.27

The grounds for conversion to a case under Chapter 7 or for dismissal
of the debtor's pending Chapter 11 bankruptcy case have been expanded.
In the absence of unusual circumstances the court specifically
identifies, the court must grant the request of a party in interest to
dismiss or convert the debtor's case if the court finds any of a list of
factors. The factors include: substantial or continuing loss to or
diminution of the estate and the absence of a reasonable likelihood of
rehabilitation; gross mismanagement of the debtor's estate by the debtor
in possession or trustee; failure to maintain appropriate insurance, the
lack of which poses a risk to the estate or to the public; unauthorized
use of cash collateral, the use of which is substantially harmful to one
or more creditors; failure to comply with any court order; untimely
failure to satisfy any reporting requirement; failure to attend the
meeting of creditors or any examination or other meeting as requested by
the trustee; failure to timely pay post-petition taxes or to file tax
returns; or, in individual cases, failure to pay domestic support
obligations.28

Addition of Chapter 11 Small Business
Provisions

Congress also has adopted new Chapter 11 bankruptcy small business
provisions to move small business cases more quickly through the Chapter
11 process. A small business case is one in which the aggregate of
noncontingent liquidated debts both secured and unsecured, excluding
debts to affiliates and insiders, does not exceed $2 million.29 For purposes of this provision, small businesses
do not include entities whose primary activity is owning or operating
real property or businesses incidental thereto.

In addition to performing the other duties set forth in Chapter 11, a
small business debtor must append to the petition - or furnish within
seven days of the filing of the bankruptcy petition - copies of its most
recent balance sheet, statement of operations, cash flow statements, and
tax returns.30 Senior management of and
counsel for a small business debtor also must attend all meetings
scheduled by the court. A small business debtor must timely file all
schedules and statements, file all post-petition financial and other
required reports, maintain insurance that is customary and appropriate
for its particular industry, timely file tax returns and pay taxes and,
most importantly, permit the trustee to inspect the business premises,
books, and records.

The trustee in a small business case is responsible for investigating
the debtor's viability, inquiring about the debtor's business plan, and
explaining the debtor's duties about monthly operating reports and other
required reports.31 The trustee will try to
obtain the debtor's agreement with respect to a scheduling order for the
case, inform the debtor of its other obligations, and take all
reasonable steps to move the case along efficiently. The trustee also
will determine if the debtor is able to confirm a reorganization plan.
Additional periodic financial reporting is required in small business
cases.

The debtor must file its reorganization plan within 300 days of the
case's commencement,32 and the plan must be
confirmed within 45 days after it is filed.33 These time limits may be extended at the
debtor's request, but the burden on the debtor to obtain such an
extension is a preponderance of the evidence and the court may only
extend such time limits if: the debtor demonstrates that it is more
likely than not that the court will confirm a plan within a reasonable
time; a new deadline is imposed when the extension is granted; and the
order extending the time is signed before the existing deadline has
expired. In a small business case, the court may conditionally approve a
disclosure statement without a hearing and may give final approval to
the disclosure statement at the confirmation hearing.34

Major Changes to Chapter 7Consumer
Provisions

Mandatory Credit Counseling and Debtor Education. To
be eligible for relief under any chapter of the Bankruptcy Code,
individuals must, within 180 days before filing, receive an individual
or group briefing from an "approved nonprofit budget and credit
counseling agency."35 This briefing, which
may take place by telephone or the Internet, must outline the
opportunities for credit counseling and "assist ... in performing a
related budget analysis."36 Exceptions are
provided for debtors who: 1) reside in a district in which the trustee
has determined that the approved agencies are inadequate to provide
counseling services; 2) face emergency situations and who sought the
required counseling but were unable to receive it within five days; or
3) are incapacitated, disabled, or on active military duty in a war
zone.37 In addition, the debtor must file a
certificate from the credit counseling agency describing the services
provided and any debt repayment plan that may have been
developed.38

Presumption of Abuse / "Means Testing" for Chapter 7
Eligibility. One of the most publicized changes in the Act is
the imposition of "means testing."39 Means
testing is a fundamental change in the Chapter 7 bankruptcy process,
because, for the first time, the court must consider the debtor's future
earnings before according the debtor relief under Chapter 7. If the
debtor's future earnings (as determined by reviewing the debtor's past
earnings) are sufficient to permit the debtor to pay the debtor's
pre-petition creditors, then the debtor's case will be dismissed, unless
the debtor elects to proceed under Chapter 11 or Chapter 13, which are
reorganization and wage-earner chapters.

The court presumes that the debtor's Chapter 7 filing is abusive, or
for an improper purpose, if the debtor's current monthly income (less
allowed expenses), multiplied by 60, exceeds the lesser of the
following: $10,000; or the greater of 25 percent of unsecured
nonpriority claims or $6,000.40 If the
debtor can repay the lesser of $10,000 or 25 percent of the debtor's
unsecured nonpriority debt (but not less than $6,000) over five years,
then abuse will be presumed.

The trustee must review all of the debtor's submissions (schedules,
tax returns, and so on) and submit a report to the court within 10 days
of the creditors' meeting at which it is determined whether abuse should
be presumed.41 Within 30 days thereafter,
the trustee must file a motion to dismiss or convert the case,42 and the clerk of the bankruptcy court must give
notice that a presumption of abuse has arisen.43

A debtor's "current monthly income" is equal to the average monthly
income the debtor (and the debtor's spouse, if filing jointly) receives
from all sources during the six months preceding the filing of the
petition, excluding Social Security payments and payments received by
victims of war crimes, crimes against humanity, or terrorism.44 Allowable expenses are determined under national
standards and include: the debtor's actual expenses in categories the
IRS recognizes but for which no specific allowance has been specified;
expenses for protection from family violence; continued contributions
for care of nondependent family members; actual expenses of
administering a Chapter 13 plan; expenses for elementary through high
school education (up to $1,500 annually per minor child); home energy
costs in excess of the allowance specified by the local standards for
housing and utilities issued by the Internal Revenue Service based on
actual expenses for home energy costs, if the debtor provides
documentation of such actual expenses and demonstrates that the actual
expenses are reasonable and necessary; 1/60th of all secured debt that
will become due in the five years after filing; 1/60th of all priority
debt; and continued contributions to tax-exempt charities, up to 15
percent of gross income.45

The debtor may rebut the presumption of abuse only by establishing
exceptional circumstances, such as a serious medical condition or active
duty military experience.46 However, the
abuse presumption does not apply to a disabled veteran whose
indebtedness was incurred while the veteran was on active duty or
performing a homeland defense activity.47

A safe harbor is granted to debtors by applying the median family
income test. Median family income is reported by the U.S. Census Bureau
for each year.48 In Wisconsin, the state
median varies depending on family size, but is between $52,411 and
$56,559 for 2003 (based on the 2003 American Community Survey taken by
the U.S. Census Bureau).49 If the debtor's
current monthly income is less than the median family income for a
family of the same or smaller size, then the motion to dismiss for
substantial abuse may not be brought.

Debtor's Attorney's Signature. In Chapter 7 cases,
the debtor's attorney's signature on a petition, pleading, or motion is
a certification that the attorney has: performed a reasonable
investigation into the circumstances giving rise to the petition,
pleading, or motion; determined that the petition, pleading, or motion
is well grounded in fact or is warranted by existing law or a good-faith
extension, modification, or reversal of existing law; and does not
constitute an abuse. Additionally, the signature affirms that the
attorney has no knowledge, after an inquiry, that any information in the
schedules filed with the petition is incorrect.50

The court may award the trustee reasonable costs, including attorney
fees, in bringing a motion to dismiss under 11 U.S.C. § 707(b), if
the court grants the trustee's motion, and finds that the debtor's
attorney violated Rule 9011 of the Federal Rules of Bankruptcy
Procedure.51

Limits on Homestead Exemption. Another major change
under the Act is the residency requirements that must be met to take
advantage of state or local homestead exemptions. Under the Act, a
debtor may elect state exemptions only in the state in which he or she
has been domiciled for the 730 days before the bankruptcy filing.52 If the debtor cannot meet the 730-day
requirement because he or she did not live in a single state for the
entire period, then the debtor may use the exemptions for the state in
which the debtor resided most of the 180 days preceding the 730-day
period (that is, between two and two-and-a-half years before the
filing). If these residency requirements render a debtor ineligible for
any state exemption, then the debtor may choose the federal
exemptions.

The debtor's use of the homestead exemption may be further limited by
a provision that reduces the applicable state law exemption to the value
of the homestead that is attributable to any portion of any nonexempt
property that the debtor disposed of within 10 years of filing the
petition with the intent to hinder, delay, or defraud creditors.53

Moreover, a debtor may exempt only up to $125,000 of the debtor's
interest in a homestead that was acquired within 1,215 days (40 months)
before the bankruptcy filing.54 This
limitation does not apply, however, to equity rolled over before the
1,215-day period from one house to another in the same state.55

Further, an absolute cap of $125,000 exists with respect to debtors
who have been convicted of a felony, the circumstances of which
demonstrate that bankruptcy filing would constitute an abuse, who have
violated certain securities laws, or who have committed intentional
torts that caused serious bodily injury or death in the five years
preceding the bankruptcy filing.56 However,
this limitation is inapplicable if the homestead property is "reasonably
necessary for the support of the debtor and any dependent of the
debtor."57

Finally, the discharge provisions under Chapters 7, 11, and 13 are
all amended to provide that the court may only enter a discharge order
if the court determines that no action or proceeding is pending under
the new homestead limitation provisions discussed above. The discharge
may be delayed until such an action or proceeding is concluded.58

Limit on Automatic Stay. The impact of the automatic
stay on creditors' collection action is substantially modified in cases
of repeat filers or if the court finds a filing to be abusive. The
automatic stay, applicable to all entities, stays certain actions
against the debtor or property of the estate. The automatic stay is
effective immediately when a bankruptcy petition is filed.59 If a debtor files a case under any chapter
(other than Chapters 12 or 15) within one year of the dismissal of a
preceding case filed by the same debtor (other than a Chapter 11 or 13
case filed after dismissal under 11 U.S.C. § 707(b)), the automatic
stay in the second case will terminate 30 days after the filing.60 However the automatic stay may be continued if,
after a hearing on motion, the court finds that the second filing was
made in good faith with respect to the creditors to whom the stay was
intended to apply. If a third case is filed within one year, then no
automatic stay goes into effect unless the court actually imposes the
stay after holding a hearing and making a finding that the filing was
made in good faith.61

With respect to both the second and third filings within one year, a
presumption arises that the filings are not in good faith. The debtor
must rebut this presumption with clear and convincing evidence.62

Ride-through. Another significant change in Chapter
7 is the elimination of the debtor's ability to retain collateral
without redemption (paying the holder of a lien on the collateral the
full amount of the secured claim)63 or
reaffirmation (agreeing to repay a pre-petition debt that otherwise
would be discharged through bankruptcy) by simply maintaining current
payments on the secured debt (known as "riding through"). While it seems
clear that Congress intended to eliminate this practice, the provisions
related to this issue are inconsistent.

In one amendment, an individual debtor in Chapter 7 is prohibited
from retaining possession of any personal property that is subject to an
allowed claim for the purchase price that is secured in whole or in part
by an interest in the property (a "purchase money security interest"),
unless the debtor "not later than 45 days after the first meeting of
creditors" either redeems the property or enters into a reaffirmation
agreement with respect to the debt secured by the property.64 If the debtor "fails to so act within the 45-day
period," the automatic stay is terminated with respect to such property,
the property is no longer included as property of the debtor's
bankruptcy estate, and the creditor may take action to collect its debt
or repossess the property under applicable nonbankruptcy law. 65 Before the expiration of the 45-day period, the
trustee may request that the stay be continued by showing the court that
the property is of consequential value or benefit to the estate, and by
providing appropriate protection of the creditor's interest.66 If such a motion is granted, the court will
order the debtor to deliver any such collateral that the debtor
possesses to the trustee.67

Despite these apparently clear provisions, another section of the Act
provides for the termination of the automatic stay and removal from the
estate of any personal property under slightly different circumstances.
In this provision, any property that is collateral for any secured claim
(not just property subject to purchase money security interests), or
that is subject to an unexpired lease, may be removed from the estate if
the debtor: 1) fails to file a statement of intent to reaffirm the
obligation within 30 days of the case filing; or 2) files a statement of
intent to reaffirm but fails to take the action specified in such a
statement, unless the reason for failing to act is the creditor's
refusal to agree to the reaffirmation on the terms set forth in the
original contract.68 Thus, the debtor is
required to file the statement of intent within 30 days of the first
date set for the meeting of creditors. This conflicts with the 45-day
period set forth above.69 Additional
legislation likely will be necessary to resolve this apparent
conflict.

Scope of Discharge. The scope of the discharge
available in a case under any bankruptcy chapter will be further limited
as follows: 1) the presumption of nondischargeability for fraud in the
use of a credit card is expanded; 2) debts in excess of $500 (reduced
from $1,225) for luxury goods incurred within 90 days before filing
(increased from 60 days before filing) are presumed nondischargeable; 3)
cash advances in excess of $750 (reduced from $1,225) taken within 70
days before filing (increased from 60 days before filing) are presumed
nondischargeable; and 4) all student loans are nondischargeable, in the
absence of undue hardship, regardless of the nature of the lender (loans
from nongovernmental and profit-making organizations previously were not
covered by the nondischargeability provisions).70

In addition, the scope of the "superdischarge" under Chapter 13
(which generally was granted after the completion of a Chapter 13 plan,
and which was much wider in scope than the discharge available under
Chapter 7) is reduced.71 The following
obligations are now nondischargeable under Chapter 13: 1) trust fund
taxes; 2) taxes for which returns were never filed or were filed late
(within two years of the petition date); 3) taxes that the debtor evaded
or for which the debtor made a fraudulent return; 4) debts arising from
fraud or false statements under 11 U.S.C. § 523(a)(2); 5)
unscheduled debts under 11 U.S.C. § 523(a)(3); 6) debts arising
from defalcation by a fiduciary under 11 U.S.C. § 523(a)(4); 7)
domestic support payments; 8) student loans; 9) debts arising from
injuries caused by the debtor's drunk driving; 10) criminal restitution
or criminal fines included in a sentence on the debtor's conviction of a
crime; and 11) civil restitution or damages awarded in a civil action
against the debtor as a result of willful or malicious injury by the
debtor that caused personal injury or death.72

Finally, the length of time between discharges has been lengthened in
most cases.73 A debtor may not receive a
Chapter 7 discharge if he or she has received a Chapter 7 or Chapter 11
discharge in a case filed within eight years of the current case
filing.74 In addition, under amended
Chapter 13, a debtor may not receive a Chapter 13 discharge if the
debtor received a discharge "in a case filed under Chapter 7, 11 or 12
of this title during the four-year period preceding the date of the
order for relief under this chapter, or in a case filed under Chapter 13
of this title during the two-year period preceding the date of such
order."75

Production of Tax Returns and Other Documents.
Finally, although not an obviously significant amendment, the new
requirement that the debtor file tax returns and other financial
statements and reports early on in every case is likely to have some
substantial effects.76 Early on in every
new case, individual debtors must file a copy or transcript of the
federal income tax return for the most recent tax reporting
period.77 Failure to produce the tax return
requires dismissal of the bankruptcy case.78 In an involuntary case, in which the debtor did
not intend to be a debtor in a bankruptcy case and therefore did not
voluntarily file the bankruptcy petition, this requirement may provide
an opportunity to get the involuntary petition dismissed from the
outset. This may seriously impact the effectiveness of involuntary
Chapter 7 filings, because without the debtor's cooperation in filing
the tax returns, the case may not proceed.

Conclusion

This article addresses some of the many changes in the practice of
bankruptcy law caused by the Act. Practitioners will need to carefully
study the new legislation and review its effect on long-standing
practices and procedures in the bankruptcy courts. Historically,
bankruptcy practitioners and courts have maintained some degree of
flexibility to meet the needs of the various constituencies who appear
in the court. While there undoubtedly will be a period of adjustment,
the ultimate result will be the continued flexibility of the courts and
the successful resolution of serious economic difficulties.